Four months after his appointment by Gordon Brown, Sir David Walker has published his interim report on the corporate governance of the UK financial system. He makes 39 recommendations aimed at addressing some of the shortcomings exposed by the financial crisis.
Sir David’s report is an insightful and considered response to the issues, and we agree with many of his proposals. In particular, his broad conclusion that the Combined Code on Corporate Governance remains fundamentally “fit for purpose” is in line with our own perspective, which we presented to IoD members at our corporate governance summit in the middle of May.
Sir David also convincingly argues that the main emphasis for the future should be on improving the behaviour pattern of boards – particularly the management challenging role of non-executive directors - rather than on introducing a new governance framework.
We are pleased to see that Sir David’s report takes up a number of our proposals in his analysis and recommendations. In particular, he highlights:
- the need for board composition to give greater regard to relevant expertise rather than the fulfilment of formal independence criteria.
- the time commitment required of non-executive directors, and the implications of this for the number of board positions that should be undertaken by one individual.
- the pivotal role played by the Chair in the effectiveness of the board.
- the need to provide non-executive directors with greater in-house support in order to fulfil their role.
However, it is disappointing to note that – despite his emphasis on the need to improve the professionalism of boards - Sir David does not mention the potential role of the Chartered Director qualification.
Sir David makes helpful proposals relating to the evaluation of board performance. He argues that this process should be undertaken by external evaluators (every 2-3 years), and disclosed in the annual report. This coincides with an IoD proposal to develop a standardised and independent board appraisal methodology.
Although Sir David is not prescriptive about the type of external board appraisal process that should be utilised, he does note that the disclosure of boardroom evaluation in terms of a pre-defined methodology is “clearly a direction for further development”. He also suggests that a common approach [to board appraisal] “may emerge over time as a matter of best practice” (paragraph 4.31, page 58).
We are delighted that Sir David has concurred with our proposal to establish a governance code for institutional investors. The new code would be placed under the remit of the FRC, and reflects the importance of developing a culture of “stewardship” amongst fund managers. This step will contribute to progress in that direction.
Executive remuneration is always a controversial area, and the Walker Report makes a number of significant proposals to improve the longer-term orientation of incentives. Sir David is right to argue that a significant proportion of variable pay should be deferred for several years. We also support greater disclosure with respect to the rewards of highly paid employees below the level of the board, although the confidentiality of individual employment contracts should be respected.
Given the role that poor risk oversight played in the financial crisis, it is unsurprising that Sir David has formulated a number of proposals in this area. However, his proposed requirement for a designated risk committee and an independent chief risk officer would not make sense for many non-financial companies (where they would dilute the overall risk management responsibility of the CEO and the board as a whole).
It is important, therefore, that this type of proposal is not automatically extended to companies outside of the financial sector, e.g. by inclusion in the Combined Code.
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